You may find businesses talking about wealth maximisation rather than profit maximisation. Why is it so popular to businesses nowadays? What is wealth maximisation?

Wealth maximisation focuses on the cash flow amount that can be generated by a course of action. The goal of wealth maximization for businesses is to maximize shareholders’ wealth or the company share’s market value or earnings per share (EPS). Some of us are just concerned about the short term benefits. However, a short term prospect can only carry out the intention of earning profit but not in generating wealth as generating wealth generally requires a long term prospect.

Why wealth maximisation is more important?

Wealth maximization goal has discounted stream of future benefits exceeding costs for any financial actions to create more wealth. As a result, wealth maximisation counts the time value of money which considers a long term approach.

Wealth Maximisation — A Modern Approach

The current approach is about the concept of wealth maximisation and this involves increasing the earning per share of the shareholders and to make best use of the net present worth. The wealth maximisation approach is more concerned with the amount of cash flow produced by a line of actions than the profits.

Wealth is equivalent to the dissimilarity between gross present worth of certain result or the course of action and the investment required to attain the estimated benefits. In wealth maximisation it stresses more on cash flows comparing to profit and thus, cash flows are taken under consideration to assess various alternatives for decision making. For instance like determining the value of a certain project.

Agency problem — Owners vs Managers

Agency problem is the conflict between shareholders and managers due to the difference of interests. Unless the managers own the company’s stock, they will not gain benefits from the wealth maximisation goal.

Earnings per share (EPS) — How to increase?

Earnings per share are a good way for you to compare companies before you make any investment. Here is how it is calculated:

EPS = Net Earnings / Outstanding Shares

EPS is the most important indicator to determine a share price which suggests a company’s profitability. To increase earnings per share, a company needs to decrease the number of shares to increase earnings for their shareholders. The company can buy back their shares to reduce the share number in the market. Moreover, they need to try to increase their revenues or cut down their expenses.

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